Better protection for client funds

Many retail investors assume when they hand over their cold, hard readies to a broker or CFD provider that their money is safe.

But as the collapse of MF Global demonstrates, that can be a fanciful assumption. Global derivatives house MF Global collapsed in 2011, after drawing on customer funds to meet its liquidity requirements.

In Australia, unlike most other developed markets, businesses that hold an Australian Financial Services licence can use client funds to hedge positions, provided they do not state anything to the contrary in their product disclosure statement. They are not, however, allowed to use the money for their own purposes.

The industry is anticipating that laws around how clients’ funds must be stored, accounted for and used, will be tightened and a group of CFD providers has banded together to raise industry standards in the lead up to the possible introduction of new regulations.

Members of the group, known as the CFD Forum, include CFD houses IG Markets, CMC Markets and GFT. Members of the group must agree to the segregation and protection of client funds. CFD providers that do not do this cannot join the forum.

Chris Fulton, CMC Markets’ head of distribution for Australia and New Zealand, says it is the business’s policy to segregate client funds in a separate account. “We don’t use funds to hedge or prop trade. But not all CFD providers do that . . . some use client funds for their own purposes."

He says clients should take comfort from the fact CFD Forum members have their processes audited by professional services firms PwC or Deloitte.

“Australia is one of the only countries globally that doesn’t require CFD providers to segregate client funds. We’re pushing for it to become law and the Forum has been talking to Treasury about this," Fulton says.

Related Quotes

Company Profile

Easy Forex’s managing director ­Robert Francis says the business never debits money from client accounts and uses its own funds to hedge.

“We do a reconciliation every day so in the event all clients withdraw their funds we still have sufficient capital," Francis says.

The business also maintains a cash surplus so it has funds if all clients make a profit. “We’ve been in this business for a while and it’s not a major stretch to use our own funds," he explains.

Matt Murphie, managing director, First Prudential Markets, which is not part of the CFD Forum, says there are many misconceptions about the use of client money.

Murphie says the business pays client money into a segregated client trust account. “In the case of our firm, we are always 100 per cent hedged and run no market risk. To ensure that this is always the case, the firm does use client money to hedge client liabilities with counter parties. Client money is at all times designated as client money and is either held in a client trust account or a client hedge account and used for no other purpose." He says the business does not engage in proprietary trading.

“Truly improving client money protection is a complex issue. Unfortunately, some of the market makers use this complexity not to achieve the goal of better client security, but to pursue a commercial agenda in line with their business model," Murphie says.

Fulton disputes his claims. “CMC Markets does not run a proprietary trading desk, nor do we use client funds for hedging or to cover other client losses. Unfortunately, most other CFD providers cannot claim the same. It’s a shame FP Markets has tried to divert the conversation from the important issue of client money and the safe segregation of client funds, a core principle of the CFD Forum that CMC Markets has co-led, for which ASIC has shown support," Fulton says.

“It’s imperative clients question the legitimacy of their provider if it is using client funds towards its own operating costs, including using client funds to cover its own hedging margin and other client losses. Any provider that does not segregate its funds poses an increased risk, not just to its clients but to the industry as a whole."

In December, 2012, ASIC released a report on how over-the-counter derivatives such as CFD houses safeguard ­client money, with fascinating results.

The report shows client funds held by CFD issuers are substantial, totalling $511 million. It also found half of the 40 CFD houses included in the research use their clients’ money as collateral to hedge their exposure to client trades.

The report noted those that do not are typically large and established CFD issuers, or are in the start-up phase with few clients and have enough money internally to hedge initially.

The report also highlighted a ­startling lack of quality control in the industry. Eighteen and 18 of the 40 CFD providers surveyed do not properly designate client accounts as trust accounts.

Almost a third did not pay client money into a compliant account by the next business day after the client money is received.

As to why regulators have not taken a closer look at the way CFD providers manage client money previously, Tamas Zsabo, head of Asia Pacific for CFD house IG Group says it’s a function of limited resources.

“There are 40 providers in this market, far more than in the UK, where barriers to entry are much higher," says Zsabo, who says the sheer numbers of CFD providers make it tough for regulators to monitor them all.

Another business attempting to give clients confidence their money is safe is Saxo Capital Markets. To give greater assurances to its clients regarding their funds, Saxo Capital Markets recently introduced the ‘Transparency of Client Money’ initiative.

“Each quarter our independent global auditor conducts a reconciliation of balances in clients’ trading accounts with the client segregated trust bank account. The results from this review is then sent out to all Saxo clients each quarter providing them with an additional level of comfort and reassurance their funds are present and accounted for, explains CEO Anthony Griffin.

“At Saxo we’re taking a proactive approach to transparency of client money, we are demonstrating to the market that client money is not an afterthought for Saxo but core to our business as AFSL holders."